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Greetings! Fools!

I have a question regarding immediate annuities versus stocks and bonds for generating retirment income streams. Hoping someone knows more about annuities than I do.

In the March 2007 AARP Bulletin, beginning on page 22 there is an article titled "Fixed for Life". It's about immediate annuities as an income producing vehicle. It makes the point that a retired couple, each 65 could purchase an annuity for $100,000 and could recieve about $584 per month as income.

If you crank through the numbers that works out to just a little over $7000 per year for about a 7% return on your initial $100,000.

That seems like a pretty high rate of return for an annuity. Any ideas?

Secondly, several articles that I have recently read say that if you want to outlive your money in retirement and leave a little for the kids you should only withdraw about 4% from your retirment savings each year. So my question is how can the insurance companies do better than the 4%? What are they investing in that can pay 7% for life. What am I missing here?

Also any ideas on annuities? Are these a good deal for the retired fool?

Retof


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retof writes,

In the March 2007 AARP Bulletin, beginning on page 22 there is an article titled "Fixed for Life". It's about immediate annuities as an income producing vehicle. It makes the point that a retired couple, each 65 could purchase an annuity for $100,000 and could recieve about $584 per month as income.

If you crank through the numbers that works out to just a little over $7000 per year for about a 7% return on your initial $100,000.

That seems like a pretty high rate of return for an annuity. Any ideas?


Don't forget that you are giving away the $100,000 principal to the insurance company when you purchase the annuity, so it's not a 7% return. You can keep your $100,000 and get a 5.25% return today on a 5-year FDIC-insured CD.

intercst
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I wouldn't take retirement finance advice from the AARP, if this is what they write about annuities.

If you take $100k and put it in laddered CDs or something else returning 5% consistantly, you can expect it to last about 24 years. Essentially, if you deplete $7k of the principal in year 1 and the remaining $93k grows at 5%, you'll have $97650 at the end of the year.

Year 2, take $7k at the beginning of the year and the remaining $90650 will be $95182.50 at the end of the year. The principal will as such deplete at a slightly accelerated pace and will "last" about 24 years, with $7k pulled every year.

You're betting, essentially, that a 65 year old won't outlive 24 years of distributions from such a strategy. Probably a decent bet. The annuity company is betting you'll die before getting 24 years of distributions. They do all sorts of risk calculations and know that they can afford to pay the average 65 year old $7k a year off of a $100k deposit. They know the life expectancy won't be 24 years and they'll likely make out in the end. They're probably investing the $100k in something other than the safety of CDs and money market accounts earning 5%, and making yet more in the process.

Mark
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Secondly, several articles that I have recently read say that if you want to outlive your money in retirement and leave a little for the kids you should only withdraw about 4% from your retirment savings each year.

An important thing to remember when comparing annuities to SWR (safe withdrawal rates) is that the 4% SWR assume you are increasing the withdrawal amount by the inflation rate, while a 7% annuity is fixed if inflation takes off you are stuck with 7%

For example assume $1,000,000 in saving. You withdraw 4% or $40,000 the next year inflation is 2.5%, your withdraw can increase to $41,000 the next year if inflation is 5% the second year you can safely withdraw 5% beyond the 41,000 or $43,050.

If inflation just increases slightly to 3.6%/year the 4% safe withdrawal rate adjust for inflation will end up increasing to more than $70,000 an annuity allow in just 15 years.
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Mark,

I think expected longevity at 65 is more than 24 years, but the annuity provider most likely uses a 60/40 equity/fixed income split which, according to the data Vanguard provides, returned an average annual 9.1% for the period 1960-2005. And as clifp notes, the annual $7000 is fixed, whereas the 4% guideline assumes annual inflation adjustment.

db
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According to this 2003 data, expected additional years for a 65 year old is 18.4

http://upload.wikimedia.org/wikipedia/commons/b/be/Excerpt_from_CDC_2003_Table_1.png
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>> According to this 2003 data, expected additional years for a 65 year old is 18.4

http://upload.wikimedia.org/wikipedia/commons/b/be/Excerpt_from_CDC_2003_Table_1.png
<<

This chart doesn't differentiate by gender. I believe most (all?) annuities will do so. It would assume a man has less than 18.4 years and a woman has more than 18.4 years, and adjust the payout accordingly so a female at any given age would receive less than a male.

If it's a 100% joint and survivor annuity that would become a moot point, though.

#29
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Retof
What you're getting from the insurance company is a bit misleading. Lets look at the specifics you've given.

If you deposit $100,000 with them (think of it as a loan), and they begin paying you an annual principal and interest payment over 24 years of $7,008 per year, this calculates to a 'lending rate' (APR) of 4.66%. And like a loan, you completely lose use of the $100,000, if you die before the 'loan' is repaid, you lose any balance and, don't forget, this 'loan' may not be insured...that is, if the insurer goes out of business, depending on your states laws governing the state's guaranty fund, you may lose the monthly payment and any balance held by the defunct insurer. Insurer defualts don't happen very often, but they do happen.

Of course, the insurance companies just love to stress that you'll 'never outlive your annuity payments'. But is this really much of any value? I mean, even if you lived to be age 100, the annual return on your investment you'd have to get to support your $7,008 annual withdrawal is 6.14%.

When listening to (or reading) the claims of an insurance company on their latest and greatest 'guaranteed' convoluted products, it helps to remember the following:

1. The insurance company invests in the same stock market I do
2. The insurance company has no more of an idea of what the markets (including the bond markets) are going to do in the future than I or anyone else does
3. Insurance companies, like any other company, may go out of business in the future, so their 'guarantees' are often only as good as their ability to pay it, and
4. Insurance companies and their minions get paid first, regardless of how my 'investments' with them perform.

When you think about it, its very difficult for an insurer to offer any value to their investments after subtracting out their expenses. This is why you should always keep insurance and investments, including annuities, separate.

BruceM
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The CDC has a gender/race specific table.

http://www.cdc.gov/nchs/data/hus/hus06.pdf#027

Interesting stuff. I've never looked at this sort of data before.
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One thing you could do is to use an immediate annuity for a portion of your retirement income.

The annuity could be your bond allocation.

What you are doing is giving up estate value,essentially trading estate value for the ability to use the money while you live.

Immediate annuities have limitations but in certain cases they are indicated. In certain cases they are appropriate.

I would not put everything into an annuity and w/o knowing your cash flow requirements we can only talk in hypotheticals.

Before you bought one I would speak with a CFP or an experienced professional who will not be compensated from the sale.



buzman

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I would never recommend putting a lot of money into any single stock, annuity, fund or anything else. Diversification is very important, IMHO.

That said, personally -- and this is NOT a recommendation to anyone who does not do his or her own very careful analysis -- I would NOT get into an annuity. I've seen other sources who agree with that. In fact, AARP recently ran a piece on them and did not make them seem very positive.

In my own case (again, MY case, strictly), within my IRA, I have some money invested in the following dividend-paying stocks and funds.

BGF
CLM
CZN
EGLE
HTE
PVX

Those should provide me with an AVERAGE 12 percent return (dividends and/or bond returns) for this year, not including any growth in stock price or extra returns.

Please keep in mind that I am NOT a professional money manager, but I do enjoy tracking my IRA investments, have done so for several years, and rather actively monitor what happens to them. I therefore make changes from time to time, as information suggests. Those who have neither the time nor inclination to do that may well want to ignore what I suggest.

Vermonter
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Wow! Thanks to all of you who took the time to reply. I learned a lot about immediate annuities.

Retof

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You have a lot of good feedback on immediate annuities - I just wanted to add one more. For many, an immediate annuity can replace or take the form of a pension - they work the same way. You trade a lump sum for an income stream. That income stream can be designed to pay for life, for a fixed duration, and/or also pay income to a spouse.

While few would argue that pensions are a bad idea, many here argue that immediate annuities are a bad idea when essentially, they are exactly the same thing. Note, I have never recommended an immediate annuity to anyone but I am not one that would say that they are a bad thing. Millions and millions of Americans have depended on pensions for generations so they cant be all that bad.
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Regarding annuities, you might also look at this;
http://www.tiaa-crefinstitute.org/research/trends/tr100106b.html

<snip summary>

During the accumulation years, participants in defined contribution retirement plans need to be sure that they are making adequate contributions to their plan and that these contributions are appropriately allocated among various asset classes. Upon retirement, participants have to decide how to generate income from their account balances. One of the most important questions is whether or not to purchase a life annuity, for all or a portion of one's retirement income. As a life annuity guarantees payment of income as long as the participant lives, it can provide significant peace of mind. As this paper will demonstrate, the life annuity also provides the maximum amount of living income. However, there are many retirees who are hesitant to purchase life annuities for a number of reasons, including: the loss of control of retirement assets: the loss of liquidity and flexibility; and the potential for early death (and consequently early loss of principal.) During the past few years there has been yet another reason for not purchasing a fixed life annuity: the belief that interest rates are currently low and that one can achieve better results by waiting to purchase the annuity when rates will be higher. (Whether rates will, in fact, be higher in a few years may be a subject for another paper.)

The purpose of this paper is three-fold: (1) to demonstrate that a life annuity is financially engineered to maximize the amount of living income payable to retirees; (2) to show the potential impact of deferring annuitization to a later age; and (3) to quantify the impact of delaying an annuity purchase during periods of rising interest rates.


Hockeypop

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